Disclaimer: I do understand the experts here are NOT tax advisors, I am just seeking advice and possible directions to pursue... And the numbers I'm using below are not my exact numbers, I simplified...

Here is what's happening to me.

- I made a disastrous investment 10 years in an annuity from The Hartford (bad advice from a banker, and I didn't do any homework by then, nor did I have a clue at that time). For the sake of using numbers, say that I deposited $200K in this annuity over the years, and the value of the contact early last year was $160K. Hence a capital loss of $40K. After 10 years. Great. The loss is primarily due to management fees piling up on top of each other, so the weak theoretical gains end up in another pocket than mine... And the tax deferral is for naught.

- Still, some form of life insurance is associated with the annuity, worth $60K (not sure to understand the math, but this is clearly stated), so entirely liquidating this contract doesn't seem like a good idea. While I can withdraw less than 75% of the contract value every year (and reinvest in a smarter way - e.g. my new portfolio of index funds) and not damage the life insurance value. Good for my kids down the road!

- So... mid last year, I withdrew a good chunk of money. Say $100K for the sake of using numbers. So one could estimate that this is associated with a capital loss of $20K...

- I was expecting a 1099-R from Hartford with all appropriate details for the events of last year, including a precise cost basis, so that I can justify the capital loss when doing my taxes. Well, I didn't get anything, I called and they said "it's a non-taxable event, hence no 1099". I said "er... yeah, no gains, I noticed, but there is a loss, so... I do need details for my taxes". After quite some back & worth, I didn't get anything, not a 1099, nor a precise value of the cost basis for the 2012 chain of events. All I got was "call your tax advisor".

Ok, I am torn here. I could...

a) make my own estimate of the cost basis and enter the data in Turbotax - would be handy to declare such capital loss to counter-balance capital gains from my regular investments. And archive all written papers (e.g. transaction details, contract value before/after the transaction) justifying my math. Still... This isn't a 1099...

b) spend a few 100 $$ on a tax advisor (which I totally hate to do). Who will probably go through the same reasoning... Unless I'm missing something (either this truly is not taxable, or I need to describe/document the whole thing in another way in Turbotax and my own archives)... I'm no tax expert for sure.

c) give up on $10K of capital losses for now, and I'll see later... Maybe liquidate the stupid annuity contract for good one day or another, when I feel that I have enough money for both my retirement & legacy to the kids... Or let it go... Still, this really annoys me because I am at the point of my career (a few years before retirement) where my tax bracket is the highest...

An annuity is an insurance product, not a direct investment. While I am not a tax-advisor, lawyer, or accountant, just a guy on an internet forum, I do believe the insurance people are right. Money lost in an annuity (or whole life insurance policy) is not deductible on your taxes. Think of it this way, if it is tax-deferred, then it is like losing money in an IRA, which is also not deductible.

No matter how long the hill, if you keep pedaling you'll eventually get up to the top.

A loss in an annuity is not a capital loss and you are not allowed to take a loss on taxes or match it against gains like a non-qualified investment. I believe you can write off the loss as a miscellaneous itemized deduction subject to the 2% floor of AGI, which is obviously less favorable and would probably require a greater than $20k loss to take advantage.

You can/should probably continue to withdraw the investment to get it into a better environment, however, if there is an associated death benefit some older annuities will allow that to stay in force. For ex, if you put in 200k and it dropped to 160k, but you have a $220k death benefit, it may be possible to withdraw, say $150k, leaving $10k behind and retain a $70k death benefit. This option makes it very attractive to keep some small amount in the annuity. Newer annuities generally don't continue to allow this, but some older ones will. You would need to consider if the money left behind is worth the trade off of the death benefit.

Raybo wrote:An annuity is an insurance product, not a direct investment. While I am not a tax-advisor, lawyer, or accountant, just a guy on an internet forum, I do believe the insurance people are right. Money lost in an annuity (or whole life insurance policy) is not deductible on your taxes. Think of it this way, if it is tax-deferred, then it is like losing money in an IRA, which is also not deductible.

If I had kept the money in there, then for sure, I agree with you. But I DID withdraw a good chunk of money ($100K in my example). To go with your analogy, if I were to withdraw money from an IRA or a 401k, this would be a taxable event, is it not? Even if it's a loss, right?

Still... agreed with the spirit of your answer. I am not 100% sure this is indeed a taxable event. Seems pretty clear to me it should, but.... is it really?

MN Finance wrote:You can/should probably continue to withdraw the investment to get it into a better environment, however, if there is an associated death benefit some older annuities will allow that to stay in force. For ex, if you put in 200k and it dropped to 160k, but you have a $220k death benefit, it may be possible to withdraw, say $150k, leaving $10k behind and retain a $70k death benefit. This option makes it very attractive to keep some small amount in the annuity. Newer annuities generally don't continue to allow this, but some older ones will. You would need to consider if the money left behind is worth the trade off of the death benefit.

Yes, that is exactly what I started to do last year and will keep going. I am bounded by not withdrawing more than 75% a year to keep the death benefit, hence a multi-year strategy.

Now the question is... what about the tax implications of my withdrawals...

MN Finance wrote:You can/should probably continue to withdraw the investment to get it into a better environment, however, if there is an associated death benefit some older annuities will allow that to stay in force. For ex, if you put in 200k and it dropped to 160k, but you have a $220k death benefit, it may be possible to withdraw, say $150k, leaving $10k behind and retain a $70k death benefit. This option makes it very attractive to keep some small amount in the annuity. Newer annuities generally don't continue to allow this, but some older ones will. You would need to consider if the money left behind is worth the trade off of the death benefit.

Yes, that is exactly what I started to do last year and will keep going. I am bounded by not withdrawing more than 75% a year to keep the death benefit, hence a multi-year strategy.

Now the question is... what about the tax implications of my withdrawals...

If you have a gain, you pay ordinary income tax. If you have a loss, you don't benefit (except the off chance you add it to your miscellaneous itemized deductions). They issued the 1099 correctly. You have nothing to report or benefit from. Effectively you have no tax implication at all. This is it.

Raybo wrote:An annuity is an insurance product, not a direct investment. While I am not a tax-advisor, lawyer, or accountant, just a guy on an internet forum, I do believe the insurance people are right. Money lost in an annuity (or whole life insurance policy) is not deductible on your taxes. Think of it this way, if it is tax-deferred, then it is like losing money in an IRA, which is also not deductible.

If I had kept the money in there, then for sure, I agree with you. But I DID withdraw a good chunk of money ($100K in my example). To go with your analogy, if I were to withdraw money from an IRA or a 401k, this would be a taxable event, is it not? Even if it's a loss, right?

Still... agreed with the spirit of your answer. I am not 100% sure this is indeed a taxable event. Seems pretty clear to me it should, but.... is it really?

If you had an IRA full of money you already paid taxes on and had a loss (basically what you're saying with the annuity), then no, it's not a taxable event (technically taxable, but no positive/negative consequence)

You may be able to do a 1035 exchange to Vanguard's deferred annuity which would provide you with a much better choice of investment options going forward, plus lower expense charges than in your present contract. Your present cost basis should carry over to the new annuity which means future growth would not ultimately be taxable till your loss was covered. By all means, check this out with a tax authority first. For example, call the IRS before you do it. Or spend a few bucks to have a CPA check current laws and regulations. And, of course, all of this is based on ordinary income rates as no capital gains are involved in annuity taxation to individuals.

MN Finance wrote:A loss in an annuity is not a capital loss and you are not allowed to take a loss on taxes or match it against gains like a non-qualified investment.

I guess this is the key sentence I missed.

Ok, the IRA analogy now resonates better. This works like a 401k, right? Gains are subject to income tax, and well, when there is no income (including the case of a loss), then there are no tax consequences (i.e. no negative number to factor in). Sigh, the whole thing sounds remarkably unfair.

Many thanks for your patience explaining basics... One thing is for sure, I'll never buy one of those Hartford annuities again...

Last edited by siamond on Wed Feb 20, 2013 4:30 pm, edited 1 time in total.

mephistophles wrote:You may be able to do a 1035 exchange to Vanguard's deferred annuity which would provide you with a much better choice of investment options going forward, plus lower expense charges than in your present contract. Your present cost basis should carry over to the new annuity which means future growth would not ultimately be taxable till your loss was covered. By all means, check this out with a tax authority first. For example, call the IRS before you do it. Or spend a few bucks to have a CPA check current laws and regulations. And, of course, all of this is based on ordinary income rates as no capital gains are involved in annuity taxation to individuals.

Hm. Interesting. I should have considered such a move last year... I might lose the death benefit in the process, though?

mephistophles wrote:You may be able to do a 1035 exchange to Vanguard's deferred annuity which would provide you with a much better choice of investment options going forward, plus lower expense charges than in your present contract. Your present cost basis should carry over to the new annuity which means future growth would not ultimately be taxable till your loss was covered. By all means, check this out with a tax authority first. For example, call the IRS before you do it. Or spend a few bucks to have a CPA check current laws and regulations. And, of course, all of this is based on ordinary income rates as no capital gains are involved in annuity taxation to individuals.

Hm. Interesting. I should have considered such a move last year... I might lose the death benefit in the process, though?

Maybe so, but if your present annuity does as well over the next 10 years as it has done in the last 10 years, that might be a small price to pay. (unless an early death is likely)

Since you have 200k, that's now 160k (or less whatever you took out), if you do a straight withdrawal, you have no tax benefit. But if you keep the money in the annuity, then you have 40k "free" growth space before you get back to your basis and then have a taxable gain. If you withdraw and invest in a non-retirement account, you will owe ongoing taxes on the gain. So, you'll want to 1035 what you can (without loosing the death benefit) to VG or other low cost company and keep it in the annuity until it overtakes the basis.

Since you have 200k, that's now 160k (or less whatever you took out), if you do a straight withdrawal, you have no tax benefit. But if you keep the money in the annuity, then you have 40k "free" growth space before you get back to your basis and then have a taxable gain. If you withdraw and invest in a non-retirement account, you will owe ongoing taxes on the gain. So, you'll want to 1035 what you can (without loosing the death benefit) to VG or other low cost company and keep it in the annuity until it overtakes the basis.

Actually, the death benefit on the original annuity is lost with the 1035 transfer to Vanguard. The OP can purchase new benefit, at a much lower cost, from Vanguard, but it will only apply to the purchase price of the new annuity.

I understand that. I'm saying leave behind as much as needed in the old annuity to retain the death benefit (as long as the numbers make sense) and then 1035 everything else to VG and let it grow until it hits the basis (or beyond). Death benefit is with the old annuity and the VG is just used as an investment without any death benefit considerations.

MN Finance wrote:I understand that. I'm saying leave behind as much as needed in the old annuity to retain the death benefit (as long as the numbers make sense) and then 1035 everything else to VG and let it grow until it hits the basis (or beyond). Death benefit is with the old annuity and the VG is just used as an investment without any death benefit considerations.

I read the Vanguard Deferred Annuity literature from end to end, and yes, you guys were (of course!) correct, I'd lose the death benefit in the 1035 transfer. And yes, the more I think about it, the less I care... Better grow the capital with a low-cost provider than wait for my death...

One of the folks who advised me on this thread suggested that I post an update on my annuity...

So I did the full 1035 transfer from Hartford to Vanguard, as advised. A little bit of paperwork, one friendly phone call from Vanguard to clarify a point, and it all happened very easily. I did lose the old death benefit in the progress (ok, I knew it), and now have a new death benefit coming with the new annuity (I elected the simplest least expensive one, i.e. give the current value of the contract to beneficiaries). I now have full flexibility to choose & tune my investments with various low fee Vanguard index funds, and I chose to focus on bonds as a) this is tax-sheltered b) I needed it for my AA. The Web site is simple and well designed.

Since the management fees for the various portfolios are between 0.47% and 0.69% (most of them at 0.59), and have no hidden fees (e.g. sales load, surrender fee), I have no doubt the portfolio value will grow over the 10 to 20 years to come. On the other hand, those fees are higher than my other investment vehicles (well, it's an annuity), so I'm not going to add any more money in there.

The only wrinkle is that Vanguard initially put the cost basis of my investment at the value of purchase, instead of the significant higher cost basis (cf. Hartford/Putnam having royally mismanaged my money). Which I noticed when received my first account statement. I called Vanguard's support, got a friendly & competent support guy who quickly told me 'yes, we noticed too, sorry about that, this will be fixed in your next account statement'. Ok, cool. I just received my new account statement, I eagerly checked, and yep, I'm good.

In the process:- I switched to much lower fees index funds, so I should *finally* make some money over time!- Support & Web site are 10 times better- I lost my old $60k death benefit, oh well. Doesn't bother me much. I'd rather have the capital grow...- I have now a nice investment ready to grow tax-free for quite a while ($35k of 'free' growth)

Me happy. I'll leave the whole thing alone for 10+ years, and will slowly withdraw $$ during my retirement as needs be. Many thanks for the good advice.